strategic uses of pipe transactions - morrison & foerster · strategic uses of pipe...
TRANSCRIPT
Strategic Uses of PIPE Transactions
Thursday, February 25, 2016
8:30 AM – 9:30 AM EST
Seminar
Presenters:
Anna T. Pinedo, Partner, Morrison & Foerster LLP James R. Tanenbaum, Partner, Morrison & Foerster LLP
1. Presentation
2. Morrison & Foerster FAQ Guide:
“Frequently Asked Questions about PIPEs”
3. Morrison & Foerster Summary Chart: “Exempt Offering Alternatives”
4. Morrison & Foerster Summary Chart:
Investor Criteria for U.S. Private Placements and Other Offerings
©
2013 M
orr
ison &
Foers
ter
LLP
| A
ll R
ights
Reserv
ed | m
ofo
.com
What’s new with
Privates and PIPEs
February 2016
NY2 766582
© 2
015 M
orr
ison &
Foers
ter
LLP
All
Rig
hts
Reserv
ed | m
ofo
.com
©
2016 M
orr
ison &
Foers
ter
LLP
All
Rig
hts
Reserv
ed | m
ofo
.com
This is MoFo. 2
Agenda • Market trends
• Strategic uses of PIPE offerings
• “20% Rule”
• Regulatory developments
This is MoFo. 3
Market Trends
This is MoFo. 4
Market Trends • Privates have become more “public”
• In an effort to improve access to capital and minimize liquidity discounts, hybrid
financing techniques have become more important
• SEC’s Office of Risk Fin published a study in 2015 (“Capital Raising in the U.S.:
An Analysis of the Market for Unregistered Securities Offerings, 2009 - 2014”)
which showed that from 2009 to 2014 there was a shift from public to private or
hybrid offerings
• The shortened Rule 144 holding period, and the popularity of PIPE transactions,
and other hybrids contributed to the rise of private or targeted offering techniques
• The new Section 4(a)(7) resale exemption likely also will contribute to reducing the
liquidity discount associated with “restricted securities”
• JOBS Act changes to general solicitation rules will make privates even less private
• Perhaps more importantly, public offerings are becoming less “public”
• Due to market developments, such as heightened volatility and concerns about
investor front-running, fewer public offerings involve traditional marketing
• Most public offerings begin as confidentially marketed public offerings
This is MoFo. 5
Market Trends (cont’d)
• Overall, companies rely on unannounced deals (PIPEs, registered directs,
CMPOs)
• Reliance on unannounced deals is unlikely to abate
• As among deal formats, reliance on PIPE transactions has declined. More
companies are eligible to use a Form S-3 for takedowns (completed as
registered directs or as underwritten confidentially marketed public offerings).
However, as has been the case since PIPE transactions were created, PIPE
transactions become increasingly important in volatile markets.
6
PIPE Market Trends
Number of Deals Dollars Raised
2015 981 $57 billion
2014 1,333 $34.6 billion
2013 1,275 $23.8 billion
2012 1,253 $36.1 billion
2011 1,246 $29 billion
2010 1,529 $39 billion
2009 1,272 $42 billion
*Data: Total Placements/Total Dollars 2009 –2015
PrivateRaise.com
This is MoFo. | 6
7
PIPEs: Structure Breakdown 2004–2015
*Financing Trends in PIPE Transactions 2004 – 2015 Placement Tracker
This is MoFo. | 7
8
PIPEs by the numbers-2014
Security Type (# of Placements) Security Type ($ millions raised)
Common Stock 772 $18,233
Preferred Stock: Convertible 118 $6,502
Preferred Stock: Non-Convertible
3 $73
Debt: Convertible 149 $5,847
Debt: Non-Convertible 32 $804
Other: Convertible 2 $780
Prepaid Warrant 27 $1,601
Equity Line 73 $741
Unknown 0 0
Total: 1176 $34,581
This is MoFo. | 8
9
PIPEs by the numbers-2015
Security Type (# of Placements) Security Type ($ millions raised)
Common Stock 678 $44,059
Preferred Stock: Convertible 122 $4,773
Preferred Stock: Non-Convertible
1 $5
Debt: Convertible 162 $6,136
Debt: Non-Convertible 27 $724
Other: Convertible 2 $7
Prepaid Warrant 27 $439
Equity Line 76 $888
Unknown 1 $5
Total: 1,097 $57,036
This is MoFo. | 9
This is MoFo. 10
Are PIPEs still relevant?
When is a registered offering better?
This is MoFo. 11
Strategic uses of PIPE transactions • PIPE transactions remain an important alternative in a number of
instances, including:
• As a means of structuring a venture capital or private equity-type investment
(which may take place in a distressed context)
• In circumstances where the issuer is seeking to finance an acquisition
• For a smaller issuer, when the smaller issuer has already tapped out its shelf
registration statement or needs to preserve its shelf capacity
• For selling stockholders (to place selling securityholder stock in an orderly way)
This is MoFo. 12
VC/Private equity PIPE • Venture capital or private equity funds will often invest in public
companies – either to increase their position or as a new investment if valuations make it attractive.
• Often a VC or a PE fund will invest in a public company as part of a recapitalization transaction.
• Why should these be structured as PIPE transactions?
• Highly customized security;
• Usually the investor will want to do its own diligence and is likely to acquire
material and non-public information that will not be capable of being disclosed by
the issuer after the transaction is completed (so the VC/PE firm will continue to be
restricted);
• The investors will likely want other contractual protections (affirmative/negative
covenants, information rights);
• The investors may want board representation;
• The investors will not be as focused on their resale opportunities or if they are
insiders/control persons will face other limitations
This is MoFo. 13
VC/Private equity PIPE (cont’d)
• These deals raise a host of issues that usually do not arise in other
PIPE transactions:
• Change of control issues:
• Company’s agreements
• Poison pill/rights plan
• NASDAQ or other change of control provisions
• Dilution for other shareholders and litigation risk
• Change of control premium issues
• Fiduciary duty and other governance issues
• Fairness opinions
This is MoFo. 14
PIPE to finance an acquisition • Why a PIPE?
• Marketing reasons:
• It may be important to share with potential purchasers a fair bit of information
about the acquisition (all material non-public information) and restrict their
ability to trade for an extended period of time
• Important to assess when this information will be shared broadly and/or when
the information will become stale
• Lack of “current information:”
• Is the acquisition material?
• Is pro forma information required to be filed?
• Pro forma information may not be available
• A comfort letter may not be available that could cover the financial information
• These considerations may make it impossible to undertake a registered
offering
This is MoFo. 15
PIPE to finance an acquisition (cont’d)
• Company would like to raise capital in advance of knowing whether
its bid has been accepted
• Private placement option
• Company will conduct a private placement to institutional investors
• Placement Agent will wall cross institutional investors and institutional investors
will agree not to trade in issuer’s stock (and, if public, in the target stock)
• Placement Agent and Company will share with investors that are wall-crossed a
PPM (or other offering materials)
• Use of proceeds will describe potential acquisition ─ at least two alternatives:
• Possible for proceeds to be escrowed and released only if Company is
winning bidder, or
• Proceeds would be released to Company regardless of whether Company
prevails and wins the bid. Company would use proceeds for future
acquisitions.
This is MoFo. 16
PIPE to finance an acquisition (cont’d)
• There are a number of special considerations if Company will pursue
a private placement
• Discount: will investors insist on a discounted price?
• “Lock up”: will investors agree to be prevented from trading for a sufficiently long
period of time? When will Company put out a release after definitive purchase
agreements are executed? What will it say? What if the acquisition falls through?
How will investors be cleansed?
• Liquidity: Investors will be focused on how quickly they can obtain
liquidity
• Company will need to agree to prepare and file a resale registration statement that
covers the resale from time to time of the securities sold to investors in the private
placement
• Company and counsel will need to consider carefully the significance of the
acquisition and, if significant, how long it will take to prepare the required historical
financials and pro forma financials
This is MoFo. 17
PIPE to finance an acquisition (cont’d)
• Investors may exact a more significant discount if the periods to file a resale
registration statement and/or to have the resale registration statement declared
effective are longer than they would expect (typically period is usually 30 to 60
days)
• Securities Exchange rules: Nasdaq imposes shareholder vote
requirements in various instances
• Big boy letters:
• The investors should acknowledge receipt of information on target or the fact that
they have not received combined financials
This is MoFo. 18
PIPE for smaller issuers • Smaller issuers are subject to the 1/3 cap for primaries.
• Unfortunately, the cap may not provide sufficient flexibility for the issuer to raise much needed capital.
• An alternative for the issuer is to structure a PIPE or a 144A or other exempt offering alongside a take down off of a shelf (subject to the 1/3 cap):
• Things to consider:
• General solicitation issues: an issuer contemplating a PIPE or other exempt
offering in close proximity to a public offering should consider whether the public
offering may have been a “general solicitation” that renders the offering exemption
unavailable for the PIPE.
This is MoFo. 19
PIPE for smaller issuers (cont’d)
• Integration Issues:
• offering only to QIBs and no more than two or three large institutional accredited investors (in reliance on no-action letter guidance), or
• offering in reliance on Section 4(a)(2) and Regulation D
• SEC CD&I Question 139.25 (Nov. 2008) clarified that under appropriate
circumstances, there can be a side-by-side private offering under Section 4(a)(2) or
Rule 506 with a registered public offering.
• CD&I focuses on how the investors in the private offering are solicited – whether by
the registration statement or through some other means that would not otherwise
foreclose the availability of the Section 4(a)(2) exemption, such as a pre-existing
relationship with the issuer.
This is MoFo. 20
PIPE for selling securityholders • A significant securityholder or group of securityholders may wish to
dispose of their securities.
• These securities may be restricted securities because:
• They were acquired in an exempt offering, or
• The securityholders are affiliates of the issuer (“control stock”)
• Why should these be structured as PIPE transactions?
• Permits the securityholders to dispose of their securities in an organized manner
without disrupting the market for the issuer’s securities.
• Helps to avoid the downward pressure on the issuer’s stock price as a result of
alternative means of disposing of the securities, such as:
• Dribbling out securities over a period of weeks
• Dumping the issuer’s stock in a block trade
• The transaction is not announced until definitive purchase agreements are signed
(the issuer’s stock will not suffer the downward pressure associated with an
overhang).
This is MoFo. 21
PIPE for selling securityholders (cont’d)
• How is this accomplished?
• By utilizing the Section 4(a)(1½) exemption:
• Can be used by institutional investors to resell restricted securities purchased in a
private placement.
• Can also be used by affiliates for the sale of control securities when Rule 144 is
unavailable.
• In a Section 4(a)(1½) transaction: • The seller must sell in a “private” offering to an investor that satisfies the
qualifications (for example, sophistication, access to information, etc.) of an investor in a Section 4(a)(2) private offering, and
• The investor must agree to be subject to the same restrictions imposed on the seller in relation to the securities (for example, securities with a restricted legend).
• Other considerations: • Requires the issuer’s cooperation to effect the PIPE transaction.
• Purchase agreement contains both issuer and selling securityholder reps & warranties.
This is MoFo. 22
PIPE Approaches for
Companies that had been Planning
US IPOs
This is MoFo. 23
Merging with and into an already public
company
• Using the life sciences sector as an example, there are a number of public
companies that were successful in raising capital to fund their clinical
development, but which have failed trials.
• Instead of liquidating and distributing their capital to stockholders, these
companies may be interested in considering merger opportunities
• An issuer that has already commenced its IPO preparations but has found
that its IPO has been delayed may consider a reverse merger into the
already public company
• Unlike the “reverse mergers” into shell companies, which raise a number of
signficant concerns, a reverse merger into an operating company can be a
worthwhile alternative
• Contemporaneous with the reverse merger, the company would undertake a
PIPE transaction to raise additional funds
This is MoFo. 24
Exchange Act listing, without a capital
raise
• An issuer that already has undertaken the work required in connection with
an IPO may find it worthwhile to repurpose its Form S-1 into a Registration
Statement on Form 10, which is an Exchange Act registration statement, and
list its securities on an exchange
• The Form 10 enables an issuer to enter the SEC reporting regime
• After a Form 10 is cleared through the SEC, the issuer will be a reporting
company, responsible for periodic SEC filings, as well as subject to
Sarbanes-Oxley requirements
• A Form 10 registration statement cannot be used to raise capital
• If the issuer wants to raise capital, it would have to conduct an exempt
offering prior to, or alongside, the Form 10 registration process
• The issuer usually will undertake a PIPE transaction
This is MoFo. 25
Foreign exchanges • Foreign securities exchanges, such as the AIM, the TASE, the Frankfurt
exchange, and various of the Nordic exchanges, have been successful in
attracting strong, technology-based companies across a range of sectors
• Founders, sponsors, or others may have advocated to have these
companies list their securities on these exchanges in order to create a
liquidity opportunity, as well as to provide a “currency” for potential
acquisitions or stock-based awards
• However, many of these exchanges have failed to develop any real liquidity
for their listed companies and the stocks have languished as a result of
market structure issues (i.e., “small currencies,” lack of market makers,
exchange rules), rather than as a result of company-specific concerns
This is MoFo. 26
Recapitalization The company could then be recapitalized as follows:
• An institutional private placement in the United States completed “at market”
by reference to the home country securities exchange (which, by definition,
will be lower than the valuation that would be ascribed for a similarly situated
company listed on a U.S. securities exchange)
• In its home country, the company will undertake to register the resale of the
securities purchased in the private placement
• The institutional private placement is followed by a rights offering in the
company’s home country to existing stockholders, allowing existing
stockholders to participate at the same price as the new institutional holders
• Contemporaneously with the institutional private placement and the rights
offering, the company will proceed to undertake an IPO in the United States
as an EGC relying on the confidential submission process; the IPO could
include a resale component, or subsequent to the IPO, the company could
file a resale for the institutional investors
This is MoFo. 27
Weighing the Alternatives
This is MoFo. 28
Why choose a registered direct? • Over a PIPE transaction?
• Same efficient marketing: If an issuer has an effective shelf registration
statement, a registered direct offering can be marketed as a PIPE transaction —
on a “stealth” basis.
• Often a preliminary prospectus is filed, making the offering known to the
public. However, the issuer and placement agent may agree not to file a
preliminary prospectus supplement until late in the process.
• Often better pricing: Investors receive registered, freely transferable securities,
thus, no ‘liquidity’ discount.
• Prompt Pricing and Closing: If the issuer has an effective shelf registration
statement (or is a WKSI that can file an automatically effective shelf) the offering
can be priced and closed promptly. In some cases, pricing can occur overnight or
in a few days.
• Not limited to accredited investors: Because these transactions are registered,
offerings can be made to any potential investor, subject to suitability requirements.
This is MoFo. 29
Why choose a registered direct? (cont’d)
• Over a traditional underwritten follow-on offering?
• Short selling: In a fully marketed underwritten offering, the market has advance
notice of the potential offering, and market participants may begin shorting the
issuer’s common stock in anticipation of the offering.
• Potentially better pricing: Depending on the length of the marketing period and
general market conditions, shorting activity in the issuer ’s securities may cause
the market price of the issuer ’s stock to decline (sometimes significantly) by the
pricing date. As a result, the pricing in a marketed follow-on generally may be
lower than the price in a registered direct offering.
• Speed and Costs: Registered directs are typically faster (and cheaper) than firm
commitment deals.
• No capital commitment: From the placement agent’s perspective, a registered
direct offering does not require any capital.
This is MoFo. 30
Reminders for registered directs • A registered direct is most efficient when the issuer already has an effective
primary shelf registration statement.
• A selling stockholder also may use a registered direct offering to sell its shares—either alone or with primary (issuer) shares.
• A registered direct offering is a “distribution” for Regulation M purposes.
• Assess the applicable Regulation M restricted period; file Regulation M notice.
• There is no overallotment option in a registered direct offering.
• An overallotment option relates principally to stabilizing in connection with a firm commitment offering and is not applicable to a best efforts agency deal like a registered direct offering, where a specified number of shares are sold to the investors directly.
• A placement agent cannot engage in market stabilizing transactions in a best efforts agency transaction, only in passive market making activities.
• NASDAQ and other 20% rule limitations are being applied to registered directs unless agents can demonstrate a broad distribution that includes retail investor participation.
• The 1/3 cap on primaries apply for smaller public companies.
This is MoFo. 31
Why a pre-marketed offering? • Assumes that the issuer already has an effective shelf registration
statement. Things to consider:
• Will the eventual offering be a public or a private offering?
• Is the issuer’s disclosure grid current? Is it necessary to file updated risk factors?
Is it necessary to provide guidance on the current quarter? on write-downs? on
anticipated ratings actions?
• What is the best approach for updating the issuer’s disclosures (if needed)?
• Plan ahead all of the required (or desired) filings (e.g., these may include: 8-K,
preliminary prospectus supplement or FWP, term sheet, press release, final
prospectus supplement).
This is MoFo. 32
Why a pre-marketed offering? (cont’d)
• Over a registered direct offering? In general, many of the advantages of a registered direct offering also apply in the context of a pre-marketed public offering.
• Wider distribution: An advantage of a registered direct offering is that it is marketed in a targeted manner. However, that often means that the offering is not as widely distributed as other public offerings, in which case a pre-marketed public offering may be attractive (it can be opened up to retail investors).
• 20% rule: If an issuer anticipates offering and selling a number of shares that exceeds 20% of the total shares outstanding prior to the offering, and those shares will be sold at a discount, a registered direct offering may not be considered a “public offering” under the rules of the applicable exchange; thus presenting shareholder vote issues under the 20% rule. A pre-marketed public offering may be an attractive alternative because it is underwritten (important for NASDAQ) and in the second (public) stage can be opened up to a broader universe of offerees.
• Perceived better pricing: Many issuers still view an underwritten offering to be the most desirable financing alternative.
• Underwriter can stabilize or over-allot (if it chooses to do so): Depending on market conditions, this may be important.
This is MoFo. 33
20% Rule
34
NASDAQ Rule 5635 Requires Shareholder
Approval for Certain Types of Transactions • Issuances that may exceed 20% of the pre-transaction total shares
outstanding (“tso”) or voting power that are priced at less than the
greater of book or market value
• Sales by officers, directors and substantial shareholders may be aggregated with
shares issued by the company
• Issuances that may result in a “change of control”
• If a transaction results in an investor or group of affiliated investors obtaining a 20%
interest, or the right to acquire such interest, in the issuer on a post-transaction basis
the transaction will constitute a change of control for NASDAQ purposes
• Notwithstanding, an exception exists for pre-existing control positions that are not
displaced by the transaction
• There are a number of ways to address the change of control issue, such as
• Providing evidence that there are holders that have more sizable holdings and
exert control
• Ensuring that the new holder does not have special governance rights
• Including a provision that holder will enter into a proxy so that any right to vote in
excess of 19.9% will be voted with the majority
This is MoFo. 34
35
NASDAQ Rule 5635 Requires Shareholder
Approval for Certain Types of Transactions (cont’d)
• Issuances that may exceed 20% of the tso or voting power of the issuer if
they are connected with the acquisition of stock of another company or, more
generally, with the acquisition of any asset(s)
• This applies to both above and below market issuances
• Issuances in connection with an acquisition where an officer, director or
substantial shareholder has a 5% or greater interest (or such persons
collectively have a 10% or greater interest) in the company or assets to be
acquired or in the consideration to be paid and the issuance of stock could
result in an increase in outstanding common shares or voting power of 5% or
more
This is MoFo. 35
36
NASDAQ’s Application of the Rules Generally
• The rules apply to issuances of equity securities and any security convertible
into or exercisable for equity securities
• “Market price” is the consolidated closing bid price on the date immediately
preceding the date of the execution of the fully binding, definitive agreement
(cut-off for use of previous day bid price is 4:00 p.m. ET)
• NASDAQ no longer allows the use of a five-day average bid price and does
not accept pricing mechanisms such as volume weighted average price
(vwap)
This is MoFo. 36
37
Use of Share Caps and Pricing Floors to avoid exceeding
the NASDAQ shareholder approval thresholds
• When the terms of the securities being offered create the potential for an
issuance in excess of 20%, the company may avoid the need for up-front
shareholder approval by including a cap on the number of shares that can be
issued or a floor on the conversion price, such that no securities may be
issued in excess of 19.9% of the pre-transaction tso without shareholder
approval
This is MoFo. 37
38
Interpretative Material Regarding the Use of Share Caps
or Pricing Floors –Alternative Outcome Transactions
• IM 5635-2 indicates that share caps and price floors are acceptable
mechanisms to avoid the need to obtain shareholder approval prior to the
completion of the transaction, provided:
• The cap or floor remains in place for the life of the security or until shareholder
approval is obtained (e.g., a cap which is only in place while an issuer is listed on
NASDAQ will be deemed defective)
• Any shares issued pursuant to such a cap would not be eligible to vote with
the shareholders on the removal of the cap or approval of the deal or any
aspect of the deal
This is MoFo. 38
39
Interpretative Material Regarding the Use of Share Caps or
Pricing Floors–Alternative Outcome Transactions (cont’d)
• Caps may not be used in connection with the issuance of securities that
include “penalty” provisions or “sweeteners” (referred to as “alternative
outcome transactions”), which are triggered based upon the outcome of the
shareholder vote
• A right of redemption would constitute a penalty provision unless the proceeds are
held in escrow pending the shareholder vote
• Notwithstanding, the issuance of convertible securities with “sweeteners” or
“penalties” may comply with the NASDAQ rules, provided that no equity
securities are issuable prior to the shareholder vote
• Following a negative vote the securities may convert into up to 19.9% or the
pre-transaction tso; however, additional votes to remove the cap would not
be permitted pursuant to the alternative outcome policy
This is MoFo. 39
40
Aggregation of Offerings For purposes of the 20% rule, NASDAQ will consider the following factors:
• Timing of the issuances (no safe harbor for transactions more than 6 months
apart)
• Commonality of investors
• Existence of contingencies between the transactions (e.g., rights of first refusal or
participation)
• Similarities between deal structures
• Commonalities as to use of proceeds
• Timing of the board of directors approvals
Note: NASDAQ will generally not aggregate a shareholder approved transaction or a
public offering with a non-approved transaction
This is MoFo. 40
41
The Acquisition Rule • An above market offering may fall under the acquisition rule rather than the
20% rule if it is completed in close proximity to an acquisition
• In determining which rule to apply to an offering, NASDAQ will rely on the
following factors:
• Proximity of the financing to the acquisition
• Timing of the board approvals
• Stated contingencies in the financing/acquisition docs
• Stated use of proceeds
Note: Proceeds from an offering may be allocated among several uses
to avoid triggering the rule
This is MoFo. 41
42
The Impact of Warrants on Equity Offerings
• The “blended average test”: If the common stock portion alone is less than
the applicable NASDAQ threshold and is priced below the greater of market
or book value, but the deal includes warrants that push the offering size over
the threshold, the transaction will require shareholder approval – unless the
warrant exercise price is at or above the greater of market or book value and
the warrants are not exercisable for at least six months, in which case the
warrants are excluded from the calculation
• The $1/8 Test: If the common stock portion alone is more than the applicable
threshold, NASDAQ will attribute at least $0.125 in value to the purchase of
the unit for each share purchasable by a warrant, regardless of whether the
exercise price exceeds the market price and book value
This is MoFo. 42
43
The Impact of Warrants on Equity
Offerings (cont’d)
• A unit in a deal with 100% warrant coverage must be priced at least $0.125
above the greater of market or book value to avoid the need for shareholder
approval (a six month exercise period will not be sufficient to exclude the
warrants from the calculation)
This is MoFo. 43
44
Voting Rights • The issuance of preferred stock that may convert at a discount to the market
price of the common stock at the date of issuance and votes on a one for one
basis with the common stock is a violation of the NASDAQ Voting Rights rule
• Note: This can be addressed by limiting the voting rights of the preferred
stock – for example: a preferred share that is convertible into common stock
at a 20% discount to market will be deemed compliance if its voting rights are
limited to 8/10ths of a vote
• Contractual board designation rights must be in line with the capital
contribution made by the investor and must include a “step down” in those
rights as the investor liquidates the position
45
Public Offering Exception • It is important to note that NASDAQ’s shareholder approval rules do not
apply to public offerings. In determining whether an offering qualifies as a “public offering” NASDAQ will consider the following factors set forth in IM5635-3:
(i) the type of offering (including whether the offering is conducted by an underwriter on a firm commitment basis, or an underwriter or placement agent on a best-efforts basis, or whether the offering is self-directed by the Company);
(ii) the manner in which the offering is marketed (including the number of investors
offered securities, how those investors were chosen, and the breadth of the
marketing effort);
(iii) the extent of the offering's distribution (including the number and identity of the
investors who participate in the offering and whether any prior relationship
existed between the company and those investors);
(iv) the offering price (including the extent of any discount to the market price of the
securities offered); and
(v) the extent to which the company controls the offering and its distribution.
This is MoFo. 45
46
Public Offering Exception (cont’d)
• In determining whether an offering qualifies as a “public offering,” NASDAQ
will also consider whether the offering was marketed to retail investors. In
addition, in most instances, NASDAQ will expect the company to issue a
press release announcing the offering in advance of the completion of the
marketing effort.
• A standard rights offering and an “at the market” offering are generally
considered “public”
This is MoFo. 46
47
Methods for obtaining Interpretative
Guidance from NASDAQ
• Telephone Interpretation – non-binding regardless of whether the issuer’s
name is provided
• Submission of Listing of Additional Shares (“LAS”) filing for the transaction
with cover letter laying out support for conclusion and providing additional
transaction detail – non-binding, but supports presumption that the
transaction complies with all NASDAQ shareholder approval and voting
rights rules and policies so long as NASDAQ provides an email confirmation
that they have completed their review
This is MoFo. 47
48
Methods for obtaining Interpretative
Guidance from NASDAQ (cont’d)
• Submission of formal request for Interpretative Guidance to the Staff – Binding Guidance
• Requires a $15,000 Non-refundable fee for accelerated consideration (one to four
weeks) or a $5,000 fee for regular course consideration (four weeks or so)
• Requires sign off from the Listing Qualifications Department and two attorneys
from the NASDAQ Office of General Counsel
Note: Do not assume that a transaction is compliant simply because a similar
structure has been accepted in the past. The rules and policies evolve
continuously, often in the absence of rule filings and written interpretive
guidance
This is MoFo. 48
49
Nasdaq request for comment • Over time, Nasdaq has not made significant changes to its shareholder
approval rules
• The request for comment addresses various aspects of the shareholder
approval rule, including change-of-control provisions, the warrant test, the
private placement provisions, and the acquisition rule
• Specifically, Nasdaq asks whether
• The 20% threshold (i.e., requiring shareholder approval for issuances of 20% or
more of pre-transaction total shares outstanding at a discount) is too restrictive?
• Whether the percentage should be higher?
• Whether there are other shareholder protection provisions that are sufficient?
• Whether the insider interest in acquired assets test is still needed?
• The comment period closed February 15, 2016, but Nasdaq welcomes
comments at any time.
This is MoFo. | 49
This is MoFo. 50
Regulatory Developments
This is MoFo. 51
Regulatory developments • Changes to the definition of “accredited investor”
• New resale exemption, Section 4(a)(7)
• One could envision relying on Section 4(a)(7) for a selling stockholder PIPE
(instead of relying on Section 4(a)(1-1/2) although it is difficult to establish a
persuasive rationale to do so
• Section 4(a)(7) could be helpful for a PIPE purchaser if the PIPE purchaser wants
to resell before the effectiveness of the resale registration statement
• SEC enforcement issues associated with pre-IPO (private company)
securities trading
• FINRA focus on private offerings
F R E Q U E N T L Y A S K E D Q U E S T I O N S
A B O U T P I P E S
Understanding PIPEs
What are “PIPEs”?
A PIPE (Private Investment in Public Equity) refers to
any private placement of securities of an already-public
company that is made to selected accredited investors
(usually to selected institutional accredited investors).
See “How is ‘accredited investor’ defined?” In a typical
PIPE transaction, investors enter into a purchase
agreement that commits them to purchase securities and
usually requires the issuer to file a resale registration
statement covering the resale from time to time of the
privately purchased securities.
Equity lines of credit are not PIPE transactions. See
“What is an equity line of credit?” below.
Are all public companies permitted to engage in PIPE
transactions, or are there eligibility requirements?
Yes, all public companies that are reporting companies
may engage in PIPE transactions. See Requirements for
an Issuer below.
Is there a limit to the number of purchasers that may
participate in a PIPE transaction?
If all of the offerees are accredited investors, there is no
limit on the number of offerees or purchasers that may
participate in a PIPE transaction. See “How is ‘accredited
investor’ defined?” below. However, to the extent that
the issuer and the placement agent intend to rely on the
exemption from the registration requirements under
Section 4(a)(2) of the Securities Act of 1933, as amended
(the “Securities Act”) and the Rule 506(b) safe harbor,
the placement agent must take care not to engage in any
marketing or sales activity that would constitute a
“general solicitation.”
How is “accredited investor” defined?
Rule 501 promulgated under Regulation D of the
Securities Act sets forth the definition of an “accredited
investor.” The definition was updated following the
passage of the Dodd-Frank Act.
What kinds of securities are sold in PIPE transactions?
PIPE transactions may involve the sale of common
stock, convertible preferred stock, convertible
debentures, warrants, or other equity or equity-like
securities of an already-public company.
There are a number of common types of PIPE
transactions, including:
the sale of common stock at a fixed price;
the sale of common stock at a fixed price,
together with fixed price warrants;
2
the sale of common stock at a fixed price,
together with resettable or variable priced
warrants;
the sale of common stock at a variable price;
the sale of convertible preferred stock or
convertible debt;
a change of control transaction; and
a venture-style private placement for an
already-public company.
What are some of the advantages of a PIPE
transaction?
A PIPE transaction offers several significant advantages
for an issuer, including:
transaction expenses that are lower than the
expenses that an issuer would incur in
connection with a public offering;
the issuer will expand its base of accredited
and institutional investors;
for fixed price transactions, investors will have
less incentive to hedge their commitment by
shorting the issuer’s stock;
the transaction will be disclosed to the public
only after definitive purchase commitments are
received from investors;
investors receive only very streamlined
offering materials or information, including
publicly filed Exchange Act reports; and
a transaction can close and fund within seven
to ten days of receiving definitive purchase
commitments.
Some of the advantages for an investor include
receiving a discount to the current market price (in
order to compensate for the initial resale restrictions)
and, once the SEC declares the resale registration
statement effective, having unrestricted, freely tradeable
securities.
What are some of the weaknesses of a PIPE
transaction?
PIPE transactions have a few disadvantages for issuers,
including:
investors will require a discount to market on
the purchase price (in order to compensate for
the initial resale restrictions);
there will be a limit on the number of “black-
out” periods for the issuer while the resale
registration statement is effective (see “What is a
‘black-out’ period?” below);
as a general matter, the offering can only be
marketed to accredited investors (see “How is
‘accredited investor’ defined?”); and
an issuer cannot sell more than 20% of its
outstanding stock at a discount without
receiving prior stockholder approval. See
“Does a PIPE transaction require any prior
approvals from regulatory agencies or self-
regulatory organizations?” below.
Traditional PIPE Transactions
What is a traditional PIPE transaction?
A traditional PIPE transaction is a private placement of
either newly-issued shares of common stock or shares of
common stock held by selling stockholders (or a
combination of primary and secondary shares) of an
already-public company that is made through a
placement agent to accredited investors.
3
Investors in a traditional PIPE transaction commit to
purchase a specified number of shares at a fixed price,
and the issuer commits to filing a resale registration
statement covering the resale from time to time of the
purchased shares. The closing is conditioned upon,
among other things, the SEC’s preparedness to declare
that resale registration statement effective.
What is a “black-out” period?
In connection with a PIPE transaction, an issuer
typically must keep a resale registration statement
effective for an agreed-upon length of time so that the
securities may be sold freely, without reliance on Rule
144. During this period, the issuer may suspend the use
of the resale registration statement to amend it or to
remedy a material misstatement or omission. This
suspension is often referred to as a black-out period.
During a black-out period, PIPE purchasers will have
limited liquidity, as they will not be able to rely on the
resale registration statement to sell the securities
purchased in the PIPE transaction. Investors will
negotiate a limit on the length and number of black-out
periods. A black-out period also may be referred to as a
“suspension period.”
How do traditional PIPE transactions differ from non-
traditional PIPE transactions?
In a traditional PIPE transaction, investors enter into a
definitive purchase agreement with the issuer in which
they commit to purchase securities at a fixed price.
Thus, the investor bears the price risk from the time of
pricing until the time of closing—a period ranging from
three to thirty days, depending on the SEC’s review of
the resale registration statement. The issuer is not
obligated to deliver additional securities to the PIPE
investors if the stock price fluctuates (or for any other
reason).
Investors in a traditional PIPE do not fund when they
enter into a purchase agreement. Instead, the issuer
then files a resale registration statement covering the
resale from time to time of those securities by the PIPE
investors. The transaction closes once the SEC indicates
its preparedness to declare the resale registration
statement effective. Consequently, investors in a
traditional PIPE transaction have a resale registration
statement available at the time of closing.
Non-traditional transactions generally are structured
as private placements with follow-on (or trailing)
registration rights. This means that a closing is
scheduled when investors enter into a definitive
purchase agreement. Investors fund and the transaction
closes. Post-closing, the issuer has an obligation to file a
resale registration statement and use its best efforts to
have it declared effective.
Typically, the purchase agreement or a separate
registration rights agreement outlines specific deadlines
for the issuer to file, and then to seek effectiveness of,
the resale registration statement. Some PIPE
transactions require the issuer to make penalty
payments for failure to meet those deadlines.
In the case of a PIPE structured as a private placement
with follow-on registration rights, the investor will not
have the benefit of a resale registration statement for
some time—usually 45 to 90 days following the closing.
During that period, investors will hold restricted
securities.
4
What are the standard terms of a traditional PIPE
transaction?
A traditional PIPE transaction generally involves the
following features:
private placement to selected accredited
investors;
investors irrevocably commit to purchase a
fixed number of securities at a fixed price, not
subject to market price adjustments or to
fluctuating ratios;
purchase agreements generally contain a
limitation on black-out periods;
immediately following execution of purchase
agreements with investors, the issuer files a
resale registration statement covering resales
from time to time of the restricted securities to
be sold in the transaction, naming the
purchasers as “Selling Stockholders”;
closing of the PIPE transaction occurs
promptly upon notice of the SEC’s willingness
to declare the resale registration statement
effective; and
the resale registration statement is effective
until shares may be sold free of restrictions
under Rule 144.
Does the placement agent or a lead investor control the
process in a traditional PIPE transaction?
In a traditional PIPE transaction, the process is
controlled by the placement agent, rather than by a lead
investor. The placement agent conducts its own
business and financial due diligence.
Do investors conduct their own due diligence in a PIPE
transaction?
Investors generally limit their diligence investigation to
discussions with management and the company’s
independent auditors. Traditional PIPE purchasers
generally do not negotiate for themselves ongoing
negative covenants or covenants relating to information
rights or corporate governance.
When does the PIPE purchaser in a traditional PIPE
transaction pay for the securities?
No money is exchanged when the purchase agreement
is executed. Purchasers pay the purchase price only
when they are informed that the resale registration
statement is ready to be declared effective.
What are the other closing conditions for a traditional
PIPE transaction?
A traditional PIPE transaction generally involves the
following closing conditions:
the issuer must update the representations and
warranties made in the purchase agreement
(which are similar to those contained in an
underwriting agreement) and deliver a comfort
letter and legal opinions (including a 10b-5
negative assurance relating to the private
placement memorandum and the resale
registration statement) to the placement agent;
there can have been no material adverse
change since execution of the purchase
agreement; and
the SEC must have stated its willingness to
declare the resale registration statement
effective.
5
Purchasers will receive legended securities at the
closing. However, a purchaser can receive clean
(unlegended) securities—either at the closing or
afterwards—by delivering to the issuer’s transfer agent
a certificate (in contemplation of transferring or
otherwise disposing of the shares) acknowledging that
the purchaser recognizes its obligation to deliver a
prospectus to any prospective purchaser of the shares
and making certain representations concerning future
sales of the shares.
Typically, the resale registration statement is declared
effective on the day of (but subsequent to) the closing or
on the following business day.
How does a traditional PIPE transaction settle?
A traditional PIPE transaction settles outside of the DTC
(Depository Trust Company) system. Investors receive
actual physical stock certificates representing the
securities. The issuer works with its transfer agent to
make arrangements for the closing of the transaction.
What are the benefits of traditional PIPE transactions
compared to non-traditional PIPE transactions?
By comparison to a non-traditional PIPE transaction,
which is structured as a private placement with follow-
on registration rights, a traditional PIPE transaction
involves less uncertainty, market risk, and illiquidity.
Purchasers in a traditional PIPE transaction are not
required to close until a resale registration statement is
available for subsequent sales of the purchased shares.
Traditional PIPE purchasers can obtain unlegended
shares at, or shortly after, closing, which allows them
flexibility in disposing of the shares.
For most registered investment funds, securities
purchased in a traditional PIPE transaction are counted
in the funds’ public basket.
Non-traditional PIPE Transactions
What are the standard terms of non-traditional (or
structured) PIPE transactions?
A non-traditional (or structured) PIPE transaction
generally involves the following features:
a private placement to selected accredited
investors;
investors commit to purchase securities at a
fixed price or at a variable/reset price;
for transactions involving variable/reset
pricing, the purchase agreement generally
contains specific pricing parameters, which
may include a cap on the maximum number of
shares that may be issued to the PIPE
purchasers;
the purchase agreement generally contains a
limitation on black-out periods;
the transaction closes and funds promptly after
investors execute purchase agreements;
the issuer files a resale registration statement
covering resales from time to time of the
restricted securities sold in the PIPE
transaction, naming the purchasers as “Selling
Stockholders”;
the issuer may be obligated to make penalty
payments if it fails to file the registration
statement within an allotted period, or if the
issuer fails to use its best efforts to have the
6
registration statement declared effective within
a defined period; and
the resale registration statement is kept
effective until shares may be sold freely under
Rule 144.
When does the purchaser pay for the securities in a non-
traditional PIPE transaction?
In a non-traditional PIPE transaction, the purchaser
pays for the securities at the closing, which takes place
promptly after the execution of all of the applicable
purchase agreements. Purchasers pay for and receive
restricted securities bearing a Securities Act legend.
Unlike purchasers in a traditional PIPE transaction,
purchasers in a non-traditional PIPE transaction will not
have the immediate benefit of an effective resale
registration statement.
What are other closing conditions and covenants in
non-traditional PIPE transactions?
A non-traditional PIPE transaction generally involves
the following closing conditions:
the purchase agreement contains standard
representations and warranties (similar to
those contained in an underwriting
agreement), which will be brought down at
closing;
for variable/reset deals, the purchase
agreement also may contain covenants
requiring the future issuance of additional
securities by the issuer at no cost to the
purchaser;
the purchase agreement may, depending on
the nature of the purchaser, contain ongoing
covenants relating to corporate governance
(board representation or observer rights,
blocking rights, etc.) or information
requirements (regular deliveries of public
filings or other information to the purchaser);
the issuer must deliver a comfort letter and
legal opinions to the placement agent;
each investor must deliver to the issuer and the
issuer’s transfer agent a certificate as to the
investor’s compliance with the prospectus
delivery requirements in order to obtain
unlegended stock certificates in the future; and
there can have been no material adverse
change since execution of the purchase
agreement.
Do purchasers receive restricted (legended) securities at
closing?
Yes. At the closing of a non-traditional PIPE
transaction, purchasers receive legended securities.
Typically, purchasers will hold these restricted
securities for a period of 45 to 90 days (or longer)
following the closing. During this period, the issuer will
file the resale registration statement with the SEC and
seek to have it declared effective. If the issuer fails to
meet any of the deadlines for filing or effectiveness
outlined in the purchase agreement, the issuer may be
required to make penalty payments to the purchasers.
Purchasers have limited liquidity while the resale
registration statement is pending. Once the resale
registration statement is declared effective, the
purchasers can sell their securities pursuant to the resale
registration statement, although they will be required to
deliver their legended stock certificates and a legal
opinion to the transfer agent in advance of any trade.
This process often results in significant delays.
7
Is a registered direct transaction a PIPE?
Although some of the features of a registered direct
offering (i.e., sales to selected institutional investors by a
placement agent) give it the appearance of a private
placement, a registered direct offering is a public
offering. The offered securities are sold pursuant to an
effective registration statement. Investors receive a
preliminary prospectus (or red herring) during the
marketing phase and a final prospectus prior to closing.
The offering closes through DTC and investors receive
their shares through DTC rather than receiving physical
certificates like they would in a PIPE transaction.
Pricing and Other Negotiating
Points of PIPE Transactions
Will purchasers agree to purchase securities at a fixed
price or a variable price?
PIPE transactions may be fixed price or variable/reset
price transactions.
Variable/reset price transactions often include price
protection. For example, investors seek “downside
protection” by negotiating rights for themselves that
protect the value of their investment in the event of a
downward price fluctuation. Conversely, issuers may
negotiate a “cap” or “floor” to limit their exposure with
respect to the maximum number of shares that may be
issued as a result of stock price fluctuations or other
conditions.
How is the price set?
The price is set through discussions between the
placement agent and the issuer, just as it is during the
course of an underwritten (firm commitment) offering.
Typically, PIPEs are priced at a modest discount to the
closing bid price for the stock to compensate for the
temporary illiquidity of the purchased shares. Often, in
variable/reset transactions, the price is set based on a
formula that relates to the average closing price of the
stock over several days preceding the pricing.
Who bears price risk?
In a fixed price transaction, the purchaser bears the
price risk during the period from execution of the
purchase agreement until the closing.
In a variable/reset price transaction, the price risk is
shared between the investor and the issuer. Usually, the
investor will negotiate some price protection for itself.
What are the other frequent negotiating points in PIPE
transactions?
In addition to negotiating specific carve-outs for
representations and warranties, the placement agent,
purchaser, and issuer typically negotiate the following
points:
whether issuer’s counsel will include a 10b-5
negative assurance in its opinion;
whether the issuer will be required to cause its
independent auditor to furnish the placement
agent (if any) with a comfort letter at closing;
whether there will be a limitation on the length
and number of black-out periods;
whether there will be a time limit for filing the
resale registration statement following
execution of the purchase agreements;
the length of time given to the issuer to have
the resale registration statement declared
effective (most often 60 days); and
8
whether there will be penalty payments tied to
the filing and effectiveness of the resale
registration statement.
Sharing Transaction Details with Potential Investors
Who may participate in PIPE transactions?
Accredited investors are eligible to participate in PIPE
transactions. Funds, including mutual funds, pension
funds, and hedge funds, are frequent PIPE purchasers.
More recently, distressed funds and venture funds have
begun participating in PIPE transactions. Distressed
funds and venture funds typically negotiate additional
covenants in their purchase agreements relating to
corporate governance rights and information rights.
What information do investors receive?
All investors in a PIPE transaction receive the same
information: a private placement memorandum
containing the issuer’s Exchange Act documents.
Investors generally do not receive projections or other
information that has not been disclosed publicly.
Should investors sign a confidentiality agreement?
Because investors do not receive material nonpublic
information, it may not be necessary for them to sign a
general confidentiality agreement. However, the issuer
will be sharing information (the fact that the issuer is
considering a financing transaction) that is not known to
the market. Thus, the placement agent and the issuer
should obtain from each prospective investor an oral or
written agreement stating that the investor will keep
information relating to the potential offering
confidential and acknowledging that the investor
understands how confidential information must be
treated under the securities laws. Any such agreement
should contain an express agreement to refrain from
trading in the issuer’s securities. See “Regulation FD and
other Legal Concerns.” Given an already-public
company’s desire to keep information about a potential
financing in the form of a PIPE transaction confidential
until such time as a definitive agreement is executed, it
would be inconsistent for the issuer and/or the
placement agent to use general solicitation in connection
with a possible transaction.
Will investors know what a PIPE transaction is?
There are many misconceptions about PIPE
transactions, but typically, within each institution, there
is a compliance or legal person who is familiar with the
PIPE structure.
PIPE transactions have received negative press in the
past. How does the market view PIPEs today?
In the past, PIPEs have been confused with death spiral
transactions and equity lines of credit. See “What is a
death spiral or toxic convert?” and “What is an equity line of
credit?” below. Unlike PIPEs, these transactions can
result in ongoing and substantial dilution. Also, the
SEC’s enforcement division has brought a number of
actions against hedge funds and other investors in PIPE
transactions that traded in advance of the public
announcement of the transaction while in possession of
material nonpublic information or that engaged in
manipulative trading practices in connection with PIPE
transactions.
PIPE deals have grown in popularity over the past few
years. The types of issuers taking advantage of the PIPE
structure has broadened from small companies to New
York Stock Exchange traded companies. In addition,
the numerous publications, websites, and conferences
9
that cover the PIPE market have made the PIPE
structure more familiar to investors.
Requirements for an Issuer
What kinds of issuers finance through PIPE
transactions?
Historically, PIPE transactions have been used by
issuers with significant capital requirements, including
life science and biotech companies, real estate
investment trusts, and technology companies.
In recent years, as the volume of PIPE transactions has
increased, the variety of issuers coming to market with
PIPE transactions also has increased. PIPE issuers now
range in size and include larger, more established
companies. These issuers usually view PIPE
transactions as an alternative to shelf takedowns,
traditional follow-on offerings, or bought deals. In
addition, many issuers use PIPE transactions to provide
liquidity to existing stockholders. In some instances,
where a shelf takedown may not be possible, such as in
connection with financing an acquisition, a PIPE
transaction may be the only choice.
What are an issuer’s typical considerations relating to
a PIPE transaction?
In evaluating a PIPE transaction as a possible financing
option and in considering a PIPE transaction versus
other potential financing options, an issuer should
generally consider the following:
usually the issuer cannot issue more than 20%
of its total shares outstanding at a discount in
the PIPE transaction without shareholder
approval and prior notification to exchanges
(see “Does a PIPE transaction require any prior
approvals from regulatory agencies or self-
regulatory organizations?”) below;
the purchaser (not the issuer) bears market
risk;
the transaction can close quickly, provided
there is no SEC review;
the format is familiar to sophisticated
institutional investors;
PIPEs typically involve a modest discount to
market price;
the SEC is comfortable with the PIPE format;
and
PIPEs do not have any of the negative effects
associated with a “death spiral,” preferred
stock offering, or an equity line of credit. See
“What is a death spiral or toxic convert?” and
“What is an equity line of credit?” below.
Must an issuer be eligible to use a Form S-3 registration
statement on a primary basis in order to complete a
PIPE transaction?
Issuers need not be Form S-3 eligible on a primary basis
in order to complete a PIPE transaction, but must be
eligible to use Form S-3 on a resale basis. An issuer may
use a Form S-1 or a Form S-3 registration statement as a
resale shelf registration statement in connection with a
PIPE transaction, but using a Form S-3 is cheaper and
less time-consuming than using a Form S-1. The Form
S-3 is less burdensome and may be updated by the
periodic filing of Exchange Act reports, without the
need to file post-effective amendments.
10
What are the eligibility requirements for use of a Form
S-3 registration statement for resales?
In order to use Form S-3 for resales (secondary shares):
1. An issuer must:
be organized, and have its principal business
operations, in the United States or one of its
territories;
have a class of securities registered pursuant to
Section 12(b) of the Exchange Act or a class of
equity securities registered pursuant to Section
12(g) of the Exchange Act, or be required to file
reports pursuant to Section 15(d) of the
Exchange Act; and
have been public and have timely filed all
required filings for a period of at least 12
calendar months immediately preceding the
filing of the Form S-3 and have filed all
required reports in a timely manner; and
2. The issuer, and its consolidated and
unconsolidated subsidiaries, must not, since the end of
the last fiscal year for which certified financial
statements of the issuer and its consolidated
subsidiaries were included in an Exchange Act report:
(1) have failed to make any required dividend or
sinking fund payment on preferred stock or
(2) defaulted on the terms of any borrowing or on any
long-term lease, which defaults in the aggregate are
material to the financial position of the issuer and its
consolidated and unconsolidated subsidiaries, taken as
a whole.
May an issuer use an existing shelf registration
statement to complete a PIPE transaction?
Generally, if an issuer has a shelf registration statement
on file, it is a primary shelf registration statement
covering the sale by the issuer of its newly issued
securities. An issuer may have a shelf registration
statement on file that includes primary (issuer) shares
and secondary (selling stockholder) shares. In that case,
the issuer may be able to use that registration statement
for a PIPE and name the PIPE purchasers as the “selling
stockholders.” Generally, though, the issuer must file
and have declared effective a resale registration
statement covering the resale by the PIPE purchasers (a
selling stockholder shelf registration) from time to time
of the securities that were purchased in the PIPE
transaction.
Does a PIPE transaction require any prior approvals
from regulatory agencies or self-regulatory
organizations?
A PIPE transaction may require prior approval from the
exchange on which the issuer’s common stock is quoted
if the transaction will be completed at a discount and
may result in the issuance of 20% or more of the issuer’s
total shares outstanding. The issuer should consider not
only the effect of completing the proposed PIPE
transaction, but also, if the issuer has completed other
private transactions within the same six-month period,
the aggregate effect of such transactions, all of which
may be aggregated by the exchange. Each of the New
York Stock Exchange, the NYSE MKT, and Nasdaq has
a similar requirement.
A New York Stock Exchange-listed company must
comply with Rule 312.03(c), which requires that the
issuer obtain shareholder approval prior to the issuance
of common stock, or of securities convertible into or
exercisable for common stock, in any transaction or
series of related transactions if: (1) the common stock
has, or will have upon issuance, voting power equal to,
11
or in excess of, 20% of the voting power outstanding
before the issuance of such stock or of securities
convertible into or exercisable for common stock; or
(2) the number of shares of common stock to be issued
is, or will be upon issuance, equal to, or in excess of,
20% of the number of shares of common stock
outstanding before the issuance of the common stock or
of securities convertible into or exercisable for common
stock. Shareholder approval is not required under this
rule if the common stock is sold in a private financing
for cash, at a price at least as great as each of the book
and market value of the issuer’s common stock.
Section 713 of the NYSE MKT Company Guide
requires that an issuer obtain shareholder approval for a
transaction involving (1) the sale, issuance, or potential
issuance by the company of common stock (or securities
convertible into common stock) at a price less than the
greater of book or market value which, together with
sales by officers, directors, or principal shareholders of
the company, equals 20% or more of presently
outstanding common stock; or (2) the sale, issuance, or
potential issuance by the company of common stock (or
securities convertible into common stock) equal to 20%
or more of presently outstanding stock for less than the
greater of book or market value of the stock.
Rule 5635 of the Nasdaq Marketplace Rules requires
that an issuer obtain shareholder approval in connection
with a transaction other than a public offering,
involving: (1) the sale, issuance or potential issuance by
the issuer, at a price less than the greater of book or
market value, of common stock (or securities
convertible into or exercisable for common stock) that,
together with sales by officers, directors or substantial
shareholders of the company, equals 20% or more of
common stock or 20% or more of the voting power
outstanding before the issuance; or (2) the sale, issuance,
or potential issuance by the company, for less than the
greater of book or market value, of common stock (or
securities convertible into or exercisable for common
stock) equal to 20% or more of the common stock or 20%
or more of the voting power outstanding before the
issuance.
Shareholder approval also may be required by the
rules of the securities exchanges for a private placement
completed in connection with an acquisition, or a
private placement that results in a change of control, or
a private placement involving related parties.
Regulation FD and Other Legal Concerns
How does an issuer ensure that it has complied with
Regulation FD in the context of conducting a PIPE
transaction?
An issuer is owed a duty of confidence from its agents,
such as its placement agent, accountants, and other
participants in the PIPE process. Generally, an issuer
does not share any information with potential investors
that has not already been included in the issuer’s
Exchange Act reports.
A private placement memorandum for a PIPE
transaction usually contains the issuer’s Exchange Act
reports, together with legal disclaimers. It is prudent to
limit the information contained in the private placement
memorandum unless the issuer will be receiving signed
confidentiality agreements. Although the issuer is not
sharing material nonpublic information about its
business with potential PIPE investors, the issuer is
sharing its plans concerning a potential financing
transaction. The fact that the issuer is contemplating a
12
PIPE transaction may itself constitute material
nonpublic information. This will depend on the
particular facts and circumstances. In any event,
however, an issuer will not want to be forced to make a
premature disclosure regarding a financing.
The issuer should ensure that, before the placement
agent reveals the issuer’s name, the placement agent
obtains an oral or written agreement from each potential
purchaser it contacts that information shared will be
kept confidential, and that agreement contains an
explicit undertaking on the part of the potential
purchaser to refrain from trading in the issuer’s stock.
Given that an issuer that is contemplating a PIPE
transaction generally seeks to preserve its flexibility and
only make a disclosure once definitive agreements have
been executed, it is unlikely that an issuer will want to
engage in any form of general solicitation, even if
permissible.
What must the placement agent do in order to comply
with Regulation M?
Most PIPE transactions are “distributions” for purposes
of Regulation M. The placement agent must refrain
from making a market in the issuer’s securities during
the applicable Regulation M “restricted period.”
Depending on the average daily trading volume of the
issuer’s security, the restricted period for an agent
participating in a PIPE transaction is either one or five
days prior to the pricing (as opposed to the funding or
closing of the transaction). The placement agent also
must file a Regulation M notice with FINRA.
What are the sources of the “primary” versus
“secondary” offering questions that some issuers have
received in connection with resale registration
statements that have been reviewed?
Certain issuers that have filed resale registration
statements to cover the resale of shares originally
offered in a PIPE transaction have received comments
from the SEC questioning whether it is appropriate for
the issuer to use a resale registration statement (rather
than a primary registration statement) for those shares,
particularly in the case of PIPE transactions involving
convertible securities. This is especially the case for
small cap issuers, as well as for issuers that have sold a
disproportionately large number of shares in a PIPE,
which has been understood to mean shares in excess of
33% of the total shares outstanding prior to the PIPE
transaction.
In these cases, the SEC will take a look at the facts and
circumstances of the issuance and the resale registration
statement. The SEC will look at the factors it outlined in
its 1997 interpretative guidance. Specifically, the SEC
will consider: the amount of securities involved; how
long the securities have been held; whether the
investors are at market risk from the time they purchase
the securities; the circumstances under which the
securities were acquired; and whether it appears the
seller is acting as a conduit for the issuer. Of course, to
the extent the SEC is comfortable that the private
placement was properly completed, the issuer can
proceed with the use of the resale registration
statement.
The SEC has said that in instances where it will not
permit the resale registration statement to proceed, the
issuer can cut back the number of shares and then file a
13
second resale registration statement for the shares that
were cut back.
Equity Lines of Credit, “Future-Priced” Securities,
and Death Spiral or Toxic Converts
What is an equity line of credit?
Under an equity line of credit, the company enters into
an agency agreement with an investor pursuant to
which the company has the right, during the term of the
equity line and subject to certain conditions, to put its
securities to the investor.
Some equity lines of credit are completed using a shelf
registration statement and others are completed as
private placements with an obligation to register the
resale of the securities sold under the equity line.
What is a “future priced” security?
Future priced securities are convertible securities, often
issued through a private placement or in a Regulation S
offering. For example, death spiral or toxic converts are
“future priced” securities. See “What is a death spiral or
toxic convert?”
The conversion price or conversion ratio of the
security is tied to a percentage discount to the market
price of the underlying common stock at the time of
conversion. As a result, the conversion price floats, or
varies, based on the market price of the underlying
common stock. The lower the market price at the time
of conversion, the greater the number of underlying
shares that will be issued upon conversion.
What is a death spiral or toxic convert?
The terms death spiral or toxic convert refer to a
privately placed convertible security that has a floating
conversion ratio, without a “floor.” The conversion
ratio of the security adjusts based upon the market price
of the company’s securities at some point in the future,
usually at the time of conversion. Death spirals or toxic
converts typically reset or adjust downward (to protect
the investor) not upward (to protect the company).
Death spirals or toxic converts typically are priced at
some discount to the company’s closing bid price over a
period of days preceding the pricing date. This price
can be manipulated easily. Generally, the securities are
placed by a hedge fund, instead of a broker-dealer.
These securities may have very dilutive effects on the
company’s stock.
_____________________
By Anna T. Pinedo, Partner, and
James R. Tanenbaum, Partner,
Morrison & Foerster LLP
© Morrison & Foerster LLP, 2016
Summary Chart of Exempt Offering Alternatives
Below we provide a summary comparison of various securities exemptions.
Type of Offering
Dollar Limit
Manner of Offering
Issuer and Investor
Requirements
Filing Requirement
Restriction on Resale
Blue Sky Exemption
Section 3(a)(11) None.
No limitation other than to maintain intrastate character of offering.
Issuer and investors must be resident in state. No limitation on number.
None.
Rests within the state (generally a 9-month period for resales within state pursuant to Rule 147).
Need to comply with state blue sky laws by registration or state exemption.
Section 4(a)(2)
None. No general solicitation or general advertising.
Investors must meet sophistication and access to information test so as not to need protection of registration.
None. Restricted securities.
Need to comply with state blue sky laws.
Rule 504 Regulation D
$1 million within prior 12 months.
No general solicitation or general advertising unless registered in a state requiring use of a substantive disclosure document or sold under state exemption for sales to accredited investors with general solicitation.
Available to non-reporting companies only that are not investment companies or blank check companies.
File Form D with the Commission not later than 15 days after first sale. Filing not a condition of the exemption.
Restricted unless registered in a state requiring use of a substantive disclosure document or sold under state exemption for sale to accredited investors with general solicitation.
Need to comply with state blue sky laws by registration or state exemption.
Rule 505 Regulation D
$5 million within prior 12 months
No general solicitation or advertising.
Unlimited accredited investors and 35 non- accredited investors.
File Form D with the Commission not later than 15 days after first sale.
Filing not a condition of the exemption.
Restricted securities.
Need to comply with state blue sky laws.
Rule 506(b) None.
No general solicitation or general advertising under Rule 506(b).
Unlimited number of accredited investors and 35 non-accredited investors that are sophisticated.
File Form D with SEC not later than 15 days after first sale.
Restricted securities.
No need to comply with state blue sky laws.
Rule 506(c) None.
General solicitation permitted, provided that all purchasers are accredited investors.
Under Rule 506(c), all purchasers must be accredited investors. Issuer must take reasonable steps to verify accredited investor status.
File Form D with the SEC not later than 15 days after first sale.
Restricted securities. No need to comply with state blue sky laws.
Tier 1 Regulation A
$20 million within prior 12 months, but no more than $6 million by selling security holders.
“Testing the waters” permitted before and after filing Form 1-A. Sales permitted after Form 1-A qualified.
Eligible issuer
No investor requirement.
File test-the-waters documents, Form 1- A, any sales material and report of sales and use of proceeds with the SEC.
Not restricted securities.
Subject to state blue sky laws regarding pre- offering review, filing, and anti-fraud.
Tier 2 Regulation A
$50 million within the prior 12 months, but no more than $15 million by selling security holders.
“Testing the waters” permitted before and after filing Form 1-A. Sales permitted after Form 1-A qualified.
Eligible issuer No investor requirement; however, investors who are natural persons and are not accredited investors are subject to an investment limit.
File test-the-waters documents, Form 1- A, any sales material and report of sales and use of proceeds with the SEC. Issuer subject to ongoing reporting requirements.
Not restricted securities.
Not subject to state blue sky laws regarding pre-offering review; however, subject to state blue sky filing and anti-fraud requirements.
Regulation Crowdfunding
Up to $1 million in a 12-month period.
Offering must be made solely through a platform.
Issuers that are not reporting companies, not funds, and not subject to disqualification.
Requires the preparation of a Form C, which resembles a Form 1-A.
Securities sold in an offering are subject to certain transfer restrictions for one year.
No need to comply with state blue sky laws.
Investor Criteria for U.S. Private Placements and Other Offerings
Summary Tables and Comparisons
| 1
Regulation D: Accredited Investors
• Banks and savings and loan associations. • Registered brokers or dealers. • Insurance companies. • Registered investment companies, business development
companies, small business investment companies. • Employee benefit plans established by a state or its
subdivision with assets exceeding $5 million. • ERISA plans where the investment decision is made by a
plan fiduciary, or if the plan has assets exceeding $5 million. (Or if a self-directed plan, investment decisions are made by accredited investors.)
• Private business development company under the Investment Advisers Act.
• Corporations and other entities with assets in excess of $5 million.
Source: Rule 501 of Regulation D.
• Director, executive officer or general partner of the issuer of the securities being offered (or any director, executive officer, or general partner of a general partner of that issuer).
• Natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1 million.
• Natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years (and has a reasonable expectation of reaching the same income level in the current year).
• Any trust, with total assets in excess of $5 million, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a “sophisticated person”.
• Any entity in which all of the equity owners are accredited investors.
Institutional Accredited Investor: Regulation D
This category is not a defined term in Regulation D. Instead, an offering document or agreement may limit sales of the applicable securities solely to the Regulation D accredited investor categories that are institutional in nature (i.e., to those described in Rule 501(a)(1), (a)(2), (a)(3) or (a)(7)). This limitation is imposed in Regulation D offerings when the offering participants do not want individuals to purchase securities in the offering.
Rule 144A: Qualified Institutional Buyers
• Any of the following, which owns and invests at least $100 million in securities of unaffiliated entities:
o Insurance companies.
o Registered investment companies (subject to special aggregation rules relating to fund families) or any business development company.
o Licensed small business investment company.
o Employee plan established by a state or a subdivision.
o ERISA employee benefit plans.
o Certain trust funds where the trustee is a bank or trust company, and where the participants are certain institutions.
o Business development companies.
o Corporations and other entities.
o Registered investment advisers.
• Registered broker-dealers, acting for their own accounts or the accounts of other QIBs, that owns and invests at least $10 million in securities of unaffiliated issuers.
• Any entity, all the equity owners of which are QIBs, acting for its own account or the accounts of other QIBs.
• Any bank, savings and loan or non-U.S. bank or savings and loan that owns at least $100 million in securities of unaffiliated issuers that are not affiliated with it and that has an audited net worth of at least $25 million.
Source: Rule 144A(a).
Major U.S. Institutional Investor: Securities Exchange Act
• A U.S. institutional investor that has, or has under management, total assets in excess of $100 million (for purposes of determining the total assets of an investment company under this rule, the investment company may include the assets of the family of investment companies of which it is a part).
• A registered investment adviser that has total assets under management in excess of $100 million. • Must be:
o A registered investment company; or o A bank, savings and loan association, insurance company, business development company, small business investment
company, or certain employee benefit plans; a private business development company (as defined in Rule 501(a)(2)); a 501(c)(3) entity; or a trust.
Source: Rule 15a-6 under the Securities Exchange Act.
Investor Criteria for U.S. Private Placements and Other Offerings
Summary Tables and Comparisons
| 2
Qualified Purchaser: Investment Company Act
• Any natural person who owns at least $5 million in investments.
• Any company that owns at least $5 million in investments and that is owned by or for 2 or more natural persons that are related (or foundations or trusts established for their benefit).
• Certain trusts established for the investors in the two prior bullets.
• Any person, acting for its own account or the account of other qualified purchasers, who owns and investment at least $25 million in investments.
Source: Section 2(a)(51) of the Investment Company Act.
Knowledgeable Employee: Investment Advisers Act
• An executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the investment company or an affiliated management person.
• An employee of the investment company or an affiliated management person who participates in the investment activities of the investment company or its affiliates, provided that the individuals has performed these duties for at least one year.
Source: Rule 3c-5 under the Investment Advisers Act.
Qualified Client: Investment Advisers Act
• A natural person or a company that has at least $1 million under the management of the investment adviser.
• A person or a company that investment reasonably believes either:
o Has a net worth (together with a spouse) of more than $2.1 million (as of August 15, 2016); or
o Is a “qualified purchaser” under the Investment Company Act.
• A natural person who is:
o Part of the investment adviser’s management; or
o An employee of the investment adviser who participates in the investment activities of such investment adviser, and has had such duties for at least one year.
Source: Rule 205-3 under the Investment Advisers Act.
Eligible Contract Participant: Commodity Exchange Act
• Entities with more than $10 million in assets (or an entity guaranteed by such an entity).
• Individuals with at least $10 million invested (or $5 million if the individual is hedging).
• An entity with a net worth of at least $1 million that are hedging commercial risk.
• Financial institutions.
• Insurance companies.
• Registered investment companies and similar non-U.S. entities.
• Commodity pools with at least $5 million in assets under management.
• ERISA plans with assets of at least $5 million (or that have investment decisions made by a registered commodity pool adviser, commodity trading adviser or a financial institution or insurance company).
• U.S. federal, state and non-U.S. government entities.
• U.S. registered broker-dealers and similar non-U.S. entities.
• Futures commission merchants and similar non-U.S. entities.
Source: Section 1a(18) of the Commodity Exchange Act.
BEIJING
BERLIN
BRUSSELS
DENVER
HONG KONG
LONDON
LOS ANGELES
NEW YORK
NORTHERN VIRGINIA
PALO ALTO
SACRAMENTO
SAN DIEGO
SAN FRANCISCO
SHANGHAI
SINGAPORE
TOKYO
WASHINGTON, D.C.